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Activision Blizzard Is Doubling Down on Franchise Development

The game maker just closed the books on a solid year, but soft trends in player engagement spark significant changes and efforts to boost performance.

As in its third quarter, Activision Blizzard's (NASDAQ:ATVI) fourth-quarter earnings report for 2018 was a mixture of good and bad.

On the surface, the game maker had a solid year. Revenue reached an all-time high in the fourth quarter and for the full year. Plus, management is continuing to see good results in new growth opportunities, like in-game advertising in King's mobile games.

However, underlying engagement trends near the end of the year halted the company's momentum. This translated to lower-than-expected performance in player investment (or in-game spending) in some of the company's biggest franchises, most notably in the Blizzard segment. Investors noticed and this, plus other issues, have led to the stock dropping roughly 47% from its 52-week high in October 2018.

As a result, management announced a significant restructuring to refocus resources on content development to deliver what players want faster. Here's what you need to know about the changes.

IMAGE SOURCE: GETTY IMAGES.

The Blizzard segment was the bad apple

First the good news.

For 2018, Activision Blizzard improved its top line revenue to $7.5 billion, up from $7 billion the year before, and non-GAAP (generally accepted accounting principles) earnings per share surged to $2.72, up from $2.21 in 2017. Segment performance was solid across the board. All three operating segments -- Activision, King, and Blizzard -- saw year-over-year growth in revenue and operating income during the fourth quarter.

The Activision segment (Call of Duty) saw revenue and operating income grow by 6% and 14%, respectively, year over year. While Call of Duty: Black Ops 4 (released in October 2018) held up well in a very competitive environment for shooters, especially with Epic Games' Fortnite continuing to attract a lot of players, it didn't sell enough copies toward the end of the year to deliver on management's expectations. Management blamed weak retail demand and promotional pricing activity for lower-than-expected sales.

As for King, the maker of top-grossing mobile games Candy Crush and Bubble Witch saw its first sequential growth in monthly active users since Activision Blizzard acquired the business in the first quarter of 2016. Management credited the bump in users to a successful launch of Candy Crush Friends in October. King segment revenue and operating income grew 5% and 28%, respectively, year over year.

Now for the bad.

The Blizzard segment (Overwatch, Hearthstone, and World of Warcraft) saw monthly active users decline to 35 million, down from 40 million in the year-ago quarter. This was somewhat expected, as the newness of the latest World of Warcraft expansion started to wear off in the last quarter, but management also cited weak engagement in Overwatch, which is disappointing.

Both Overwatch and Hearthstone experienced sequential declines in revenue from in-game spending -- a tell-tale sign of stale content -- and management is moving fast and aggressively to address the problem.

2019 will be a year of transition

Management talked about several things it is doing to shift resources within the company to double down on content development. One initiative in 2019 is to cut back on operating expenses to remove "duplication and inefficiency." This will involve reducing the workforce by 8% across the company -- mainly, it seems, by eliminating administrative positions. This will pave the way for management to hire new talent to beef up the development staff and invest more in the franchises that offer the highest opportunity for growth, including Overwatch and Call of Duty, which represent the company's two biggest bets in the fast-growing esports market.

CEO Bobby Kotick made similar moves about eight years ago when he shifted the company's resources away from licensed third-party games to focus on the company's biggest, wholly owned franchises. He has also been known to discontinue franchises when a title is not delivering the returns on investment that management expects. This is why the company just recently ended its partnership with Bungie by selling back the commercial rights of the Destiny franchise and eliminating the company's investment in the game.

These moves and the underperformance of in-game spending caused management's 2019 outlook to be well below what Wall Street expected. For 2019, management is now calling for revenue to be $6.025 billion, down 20% over 2018, while adjusted EPS are expected to be down 32%.

Positive changes under way

Despite the lower guidance for 2019, these are positive changes. Management is making the right moves, which should improve the company's growth and profitability well beyond 2019.

Investors of late seem to feel the same way, as the stock price is up 6% at the time of this writing, the day after the earnings release.